Saturday, October 17, 2009

The bailout stimulus for Wall Street is working!

The real fiscal stimulus, the ARRA, appears to have been dwarfed in its impact by the other stimulus, the TARP, which bailed out ailing financial institutions in the US with direct capital injections, cheap loans with relaxed standards, and implicit guarantees to raise capital at cheap rates. Therefore, though Main Street may be still struggling, Wall Street appears to be firmly back to its old ways! There is no debating the fact that the bailout stimulus has a multiplier that is massive!

The NYT writes, "It may come as a surprise that one of the most powerful forces driving the resurgence on Wall Street is not the banks but Washington. Many of the steps that policy makers took last year to stabilize the financial system — reducing interest rates to near zero, bolstering big banks with taxpayer money, guaranteeing billions of dollars of financial institutions’ debts — helped set the stage for this new era of Wall Street wealth... They (Goldman and JP Morgan) also are profiting by taking risks that weaker rivals are unable or unwilling to shoulder — a benefit of less competition after the failure of some investment firms last year... The strong are now able to wring more profits from the financial markets and charge higher fees for a wide range of banking services."

Barely a few months after fighting to remain solvent and knocking at the doors of the US Treasury and Fed with bailout pleas, the major Wall Street firms have announced a spectacular return to the good times with their second and third quarter results. Riding on a global equity market bull run, and using much the same investment banking and trading strategies and risky instruments that caused so much devastation in recent months, Wall Street and the global financial markets appear set to blow up another asset bubble. The low interest rates is fuelling the bubble by enabling banks to borrow cheaply and deploy it in making high interest loans, trading in fixed income securities (bonds and currencies), and apeculating in the markets.

Goldman Sachs and JP Morgan Chase have both announced sharp increases in their profits for the third quarter and followed it up with setting aside record sums for bonus payments during the year. Both these institutions were helped with the TARP bailout assistance at the peak of the sub-prime mortgage crisis, and the tax-payers have borne a considerable cost in sustaining them during those testing periods. They took direct capital injections and easy term loans, which have been repaid, and implicit FDIC and other government guarantees on their debts (bonds issued by them were guaranteed by FDIC) which helped raise capital at lower cost, and which continues to this day.

In the first three quarters of this year, Goldman has set aside about $16.7 billion for compensation, and is set to pay each of its 31,700 employees close to $700,000 this year in annual bonuses that will rival the record payouts that it made in 2007, at the height of the bubble.

The fortunes of the major Wall Street firms also reveals a distinct cleavage among them. Goldman and JP Morgan, which have run up massive profits, have limited consumer lending exposure and are focussed on the very activities that brought about the sub-prime mortgage crisis. Their fortunes have come from the process of trading of equities and fixed income securities, rather than lending money to businesses and consumers. In contrast, Citigroup and Bank of America, which have also not repaid the bailout money and have major consumer lending exposures, have been weighed down by their losses from those operations.

However, the stark contrast between the champagne corks popping in Wall Street and the growing unemployment reports and anemic recovery across the Main Street cannot be missed. Even as these banking majors have been aggressively pursuing old investment banking strategies with equities and fixed income securities, consumer and business lending remains virtually frozen.

Update 1Russ Roberts (yes!) on why Goldman survived the meltdown and is on course to payout nearly $23 bn in bonus payment this year.

"Goldman Sachs played the same game as Bear Stearns and Lehman Brothers — they made lousy investments financed with borrowed money. When the assets fell in value, Bear and Lehman died. They were reckless with other people's money... it (Goldman) took a little less risk and maybe hedged against that risk a little better. But part of the reason Goldman lives and thrives is that the government bailed out AIG. Almost 13 billion dollars of the money the government sent to AIG went out the door and over to Goldman Sachs. This money included loans and insurance Goldman bought on its bad bets. Some of that insurance turned out to be a bad bet, too. But Goldman didn't bear the cost. The taxpayers did."

And see also this article about why Wall Street will never learn it. Also this op-ed from Frank Rich.